#138 - David Booth: Evidence Over Noise

25:33David Booth:So the principal lesson there is just let the magic of compounding work for you. And I would say that's also true in life. I mean, you are the result of the compounding of many decisions you made over your life. And maybe that's where wisdom comes from. You talked about markets and the prices in markets reflecting the collective wisdom of millions of relatively informed participants. But how do you think about the idea, that idea, during periods when investors may appear excessively optimistic or pessimistic? Well, there's not much evidence that you can trace through what that means for stock returns.

26:12David Booth:For example, I talked to a lot of people this year, particularly at the beginning of the year, had a lot of anxiety about the state of the world and whatever and state of the economy. And, you know, markets had a pretty good year. And I also say to them, look, okay, you have a lot of anxiety today, and that's understandable. Do you think people have more anxiety today than they did during the Great Depression or during World War II when it looked like at the beginning we were losing? I mean, during the Great Recession or financial crisis, or an example would be hit home most recently in 2020 in the first quarter when the pandemic, COVID really hit, and the market's down about 30%.

26:59David Booth:People are asking me, what should we do? What's going to happen? I go, I don't know what's going to happen. But here's what I believe down to my tippy-toes. People aren't just going to take it, and firms aren't going to take it, they're going to figure out how to get back on track. And they'll try new things and get rid of old things, and there'll be winners and losers, and I don't know which the winners, which will be which. But the overall economy is likely to get back on track faster than you might think, because of good old human ingenuity. And I think it's ingenuity explains to a considerable degree why stocks have about a 10 % return over the long haul.

27:40David Booth:because when people are always trying to improve on things, if things are going well, they're trying to make it even better. And more importantly, when things go bad for people, go badly, they don't just sit there and take it. They figure out how to get back on track, and that's that human ingenuity. That's the core to all of this in terms of investing in stocks. You talked about uncertainty a little bit earlier. If uncertainty creates opportunity, How should investors distinguish between healthy risk-taking and reckless speculation? Well, it goes back to the data, right? I mean, it's managing uncertainty and investing.

28:18There are two basic ways we can deal with uncertainty, and there can be a lot of nuances

28:23David Booth:in this. But the first thing is how much you want to have in the stock market. For many people, particularly older people, you don't want to have 100 % of your money in stocks. The other part of it is how much you have in relatively riskless assets, such as money market funds or money market instruments or short-term bonds, whatever. Those are the two ways. You want to be diverse on the equity side. You want to hold the market. That produces risk. It eliminates the single stock risk we talked about. Then if the overall volatility is still too much, just use fixed income to dampen the volatility.

29:00David Booth:So with those two things, I mean, I think you can manage uncertainty pretty well. You talked about human ingenuity. What does that phrase mean to you? And why has it become such a central part of how you think about markets in the future? My fundamental belief in humans is they want to make their lives better. That's really it. And then how do you make your life better? Well, you think of new things to do or do things differently or improve upon whatever it is you're doing. uh in life then when you go to work for a firm that's with the firm as well you know and not all firms are equally successful i mean you always you have the creative destruction of schumpeter you know where uh your progress comes from a lot of it is destroying the old and and moving to the new and uh that process uh which is not random i mean it's based on ingenuity that's where progress comes from and i suppose investing is basically a bet on human ingenuity that's what investing in stocks yeah bonds i mean you don't have the ingenuity there other than you hope you get paid back but uh stocks you can uh the rewards are uncertain and uh and you are if you have if you buy the whole market you invest all the stocks really what you're betting on is uh human progress depending on a whole economy you're not you're in a stock market is a market of stocks but the stock market behaves so much differently than the individual stocks in the market and how should investors think about this during periods when the headlines may seem overwhelmingly negative and periods like this or whenever that happens going back to covid for example i just go back to first principles okay okay here's how markets work buyers and sellers are coming together and all the information i see uh in front of me that's what the market sees all that too that's already reflected in in stock prices you know a typical problem people have is they go they read you get a news item this company looks like earnings might be uh not as good as they they previously forecast then you look at the ticker and it goes uh the ticker tape and goes, you see that the stock's down quite a bit.

31:21And so what people don't realize is the information about the poor earnings prospects

31:27David Booth:is already reflected. There's nothing you can do about it. And so you don't want to go out there and sell the stock just because it looks like it's come down. It's come down to a level, in our view, on average. it goes down to a level that you have a positive expected return going forward. If people couldn't expect a good outcome from investing in stocks, they wouldn't invest. So that's what's really going on in the marketplace. Buyers and sellers are coming together, and they're coming up with prices where the buyers seem to think I can have a positive expected outcome. I know it sounds too simplistic sometimes, but it's hard to believe it could be any other way.

32:09David Booth:It doesn't mean the markets are perfect. You know, markets make mistakes, you know, but professional investors don't seem to be able to capitalize on those mistakes. So in some ways, it's kind of a moot point. But so the market is your friend, you know. Diversification is your buddy. So these are principles to live by. And when you get into a stressful situation, get back and trace these arguments through again and again. I mean, is there some reason why I'm smarter than, you know, the market's down a lot. You know, we're stressed. There's a lot of stress. Market's down. That happened to me once.

32:48David Booth:I don't sit on investment committees anymore. But back in 98, I remember I was on an investment committee and the head of it went around the world and talked about all the problems in the world. You know, the Russian default and whatever. And he goes, why should we invest in stocks at all? I said, hey, look, you've done an elegant job of describing the world situation, but I think all you've done is explain why the market's already down 30%. That kind of reasoning is difficult, but for people to get on their own here again, that's the benefit of having a professional advisor helping you out. I feel like the real insight in what you just described is what's implicit in people saying, the outlook looks poor, let's not invest.

33:35What's implicit in that is that that viewpoint is unique and that's an edge relative to the millions of market participants that are setting the price. I think if you phrased it that way, it would be more obvious that that's probably not an edge. What you're saying is not controversial or underappreciated. And I think that's the real misunderstanding in my experience.

33:57David Booth:Well, I think that's right. People just don't get that. That's why I say that's, I don't know if that's right up there with people seeing patterns that aren't there, but this idea that the economy looks like it's going to be in tough shape. Maybe I should get out. That doesn't follow because unless you identify that before the market does, I mean, if you're smarter than the market, everybody agrees. If you're smarter than the market, you can make extra returns, you know, for sure. But we don't see much evidence that even the pros can do it. And so it's, to me, kind of laughable that individual investors sitting on their own, sitting at home, can dream up a better solution than the market does.

34:40David Booth:The market is really tough to beat. People shouldn't feel anxiety about that. They should go, wow, that is cool. That is great. You know, I don't have to pull my hair out. I can accept the prices are being fair and I just make sure that I don't have more in stocks than I can tolerate. And over the long haul, in my career, there will be times when I need to adjust my asset mix based on my long-term goals, changes in objectives or changes in life circumstance. So those are reasons to change your asset allocation. Trying to outguess the market probably isn't a very good way to make investment changes.

35:22I'd like to discuss a topic that may matter more than market forecasts, which is investor behavior, which you talked about a little bit. One of your most powerful ideas is that we should judge the quality of our decisions rather than the outcomes they produce. Why is that principle so difficult for people to embrace, particularly in an environment like investing where it can be hard to distinguish skill from luck?

35:45David Booth:Yeah, I don't know why it's so tough, but it is. The outcomes are important. We're not saying outcomes are not important. They're important. I mean, maybe, I don't like to use sports analogies too much, but, you know, whatever sport, football, you know, maybe you call the right play. Say it's a pass play, but somehow it's just incomplete. You didn't execute. I mean, but you call the right play, you're the coach. It just didn't work out. But if you call the right play, that's all you can do. In investing, then, if you come up with a sensible investment program, and I would call it a program or a process, it's not at one point in time you make an investment decision, then you forget about it.

36:31David Booth:It's an investment process. So you come up with a sensible approach, and then the market doesn't behave the way you thought. In fact, it rarely behaves the way you think. It's usually either much better or much worse than you thought. Stocks do 10 % a year, but it's rare that stock returns on any one year or anywhere close to 10%. They're either higher or lower. All these add to the complexity of investing. I think one potentially helpful way to think about it is in terms of probabilities. So the right call is the one that maybe has a 60 % chance of being right. And if you constantly make the 60 % bets versus the 40 % bets, over time, the science says you'll win versus the other way.

37:22David Booth:Yeah, and that's about, I think, annual returns, if you look at stock returns year by year, I think about 60 % of the time they are positive. So one of the challenges in investing is, you know, much of what happens in that world runs counter to human intuition and often to the behaviors that are rewarded in everyday life. Why do you think successful investing frequently requires people to act differently than success does in most other pursuits? Well, part of it is this kind of self-correcting mechanism of markets. You know, some bad news comes into the market and the market adjusts, you know.

38:01David Booth:and then there's not much else to do after that. I mean, going back to COVID, based on what we know about COVID at this point, the market's down about what you would expect it to be because we thought it would be probably a two or three-year problem. So the market was down about the appropriate amount. It turns out the problem wasn't as severe as we thought it might be at the time. And so stock prices came back up and actually were nicely positive for the year. You know, that really does, for people that view the market behaviors being counterintuitive, a year like 2020 would really blow their mind.

38:43Your career has focused more on understanding how markets work than on predicting where they're going. Why do you think investors are so attracted to forecasts despite the evidence against their usefulness?

38:57David Booth:Well, you don't really fully grasp how markets work. And when you explain the way we've talked about it today, you know, it's people go, they kind of nod and they go, okay, that kind of makes sense. But by the time they get to the elevator, they've already kind of lost that reasoning. I don't know. It is hard to stick. And the good news in that is I've made a career out of talking to people about it. So, I mean, if everybody accepted it, then I'd have to retire, I guess. Jeez. It is interesting when you open the paper or read online or watch financial media on TV. The majority of it is on predictions about the future rather than thinking about how markets work and how to build portfolios that are resilient over time.

39:46David Booth:Yeah, you want to plan for to maximizing your what you view is to be your true worth. you know if you ask people um what what does true wealth mean to you um the uh and you give them choices like family friends you know health whatever you know money but with people above a certain level i mean that doesn't have to be that that high a level even you know money isn't usually uh um the primary um goal in life that you have lots of money in fact my parents were that way. That's why I said my parents didn't have much money, but for them, it was all about family. And so, and they raised a great family and, and we all benefited from it.

40:31And so they, they got what they were after, you know, and it's, you know, if I'd gone through the Great Depression and World War II, I probably, maybe I would have had the same attitude they had.

40:44David Booth:Anyway, I think people need to focus more on, on true wealth. Let's talk about financial advice for a second. You, you brought it up a little bit earlier uh financial services has historically been a sales driven industry full of what what you may have called uh noise uh why do you think so many people find noise more compelling than actual evidence going back to medicine again i mean not too many people i mean including me i can't read medical textbooks i mean you know uh so uh i have to rely on uh on a professional opinion and uh i mean it's really difficult sometimes to figure out you know doctors that are interested in making doing a lot of surgeries so they can make a lot of money versus trying to help you solve your problem but in general though i don't think we have as big a problem in medicine as you do in financial services because they're the the incentive is huge to uh to transact you You know, if you compensate a financial advisor through commissions, one thing you probably can be sure of is you're going to be trading a lot.

41:57David Booth:So we started working with financial advisors about 30 years ago, a little over. And we only work with fee-only advisors, people that charge their clients a cash fee. In other words, we don't pay advisors a commission or we don't pay them anything. And when they come to our offices, we'll buy them lunch. So in a commission, and I experienced this a lot. Back even when I was in school, I sold shoes through college and sort of make my living. It was very commission-driven. And I could watch the behavior of commission salesmen. and, you know, there was a lot of product push, just like there is in financial services.

42:44And for me, though, that was a great learning lesson

42:49David Booth:because I realized the most important thing to me is when I went home at night, I wanted to feel good about myself. And I tried early on, you know, pushing some shoes on people or selling them shoes that didn't fit and made me feel really uncomfortable. So I decided I'm just not going to do that. And that carried over to me. That was a lesson that we started Dimensional, same thing. We want to focus on the client and improving their overall experience rather than selling them funds. If we treat people well and we explain the science to them and show them a better way of applying that science, over the long haul we'll have a nice group of clients.

43:34David Booth:I never wanted to be the biggest money management firm in the world. I want to be the coolest. I mean, I think hanging out with, you know, five Nobel laureates along the way over a 45-year period, that's pretty cool. And we have, I think, the best set of clients anybody could possibly have. We, you know, we have, our performance comes and goes like everybody else's. I mean, we have periods of time when it just looks incredibly good and periods of time when the results are really disappointing. And we have the science backing us up. So when the results are disappointing, you realize, hey, look, it just didn't work out this period.

44:19But over the long haul, I mean, nothing works all the time.

44:23David Booth:If stocks always had a positive return, then the return you were to get would be the riskless rate of return. So it's this, going back to this theme that we've talked about, which is, is getting paid for uncertainty is what it's really all about. And just make sure you don't take more uncertainty than you're comfortable with. The other challenge in the financial services industry, unlike many other industries, is it's more difficult to distinguish luck from skill. And there's also tends to be less transparency. So, you know, in your, the shoe doesn't fit example, that's more obvious than, you know, Here's an investment strategy for you where the shoe may not fit, but you may not know that as easily.

45:04David Booth:Well, I don't know. A lot of the people who walked out of the shoe store with the wrong size shoe or the wrong shoe sold by other salesmen, they didn't realize it either. Until their feet started hurting. Until their feet started hurting. And in investing, eventually you realize when, based on the returns you get, that that wasn't so good after all. I think part of it as well is people think there's optimal solutions to things. In life, there's an optimal solution to the decision that you're making, and sometimes there is in life. But when you're talking about investing in stocks and public markets, that uncertainty means you don't have an optimal solution.

45:50David Booth:You just have tradeoffs. You know, I think this mix is right for me, all things considered, you know, considering all the trade-offs. You know, that's how you deal with uncertainty. And I think people really want to, in life, let's go to life again. I think people really just want to feel safe in life. And by safe, I don't mean nothing bad can ever happen to you. but safe means to me it means if uh when you something things whatever happens to you you can deal with it you can be in control of your of your process if you have something knocks you off track you can figure out how to get back on track and that's what really investing is about um if we can help people understand better how markets work they'll be able to come up with sensible solutions, probably working with an advisor.

46:51And then they can do that.

46:53David Booth:They can stay calm and feel safe in that sense. Yeah. So you know there will be setbacks, and you just have to determine what's an acceptable level. What's an acceptable level? Don't take, you know, I don't know what the individual, over the last hundred years, I don't know what one year was the worst. It was probably down about 60 % in the Great Depression, I think. But in my lifetime, I think probably down about 35 % is about the biggest drop I've seen. So prepare for that. If that would cause you to go sideways, then you have too much inequities. If you can't stand that kind of... Once a generation, you get down, the market drops about 50 % in value.

47:41David Booth:I started just before the 73-74 decline when the market was down 50%, you know. And you had the great financial crisis, same thing. Those things happen. But once you get the idea that the reason prices are dropping is they got to find a level to where going forward you have a positive expected outcome. That's really difficult for people to grasp. But that's really going on. If you have bad news, prices drop until you think that they get to a low enough level, you think, yeah, that reflects all the bad news that's out there. From that point on, there's no reason to think you won't have a positive expected outcome.

48:24Talking about financial advice and financial advisors, what do you feel separates a truly great advisor from a merely competent one? What are the characteristics?

48:35David Booth:It's an advisor can help people deal with uncertainty. I mean, and it's more than just, there's uncertainty about the market for sure. But there's uncertainty about your family life. There's uncertainty about your kids. What's they're going to do? There's uncertainty about your health. There's uncertainty about when to retire. You know, all of these, somehow a good advisor can help people think through all of these issues and all these myriads of trade-offs and then come up with a solution. You know, eyes wide open. And this seems to be all things considered, you know, the best solution for me in terms of how I invest my money, how much I save, you know, how long I work, all those kinds of things.

49:18David Booth:Those are big decisions that an advisor can help you with. It's a calm voice of reason that has, you know, evidence backing. Absolutely. We call it science-based hope. You know, people accuse me of being an optimist. And I go, I don't think I'm an optimist. But investing in public markets, I think I'm a realist. You know, I think this is the way markets work. And it's not a wish, you know, or a forecast. It's just, you know, reason, hope based on science. I mean, that's, I don't know how else you're supposed to invest. If the data wasn't favorable, you may not be so optimistic. Well, right. But then you have to question, you know, why does the stock market exist?

50:06David Booth:It doesn't give you a fair return. Why would anybody invest? That part of human nature, you know, does make sense. As we wrap up, I'd like to move beyond markets and portfolios and talk about some of the broader lessons you've drawn from your career. So if you look back on your journey from Kansas to founding Dimensional, what experiences do you feel shaped, not just how you invest, but how you think about decision making more broadly? Well, you know, it's funny. I studied econometrics when I was at Chicago, which is really using, you know, advanced quantitative methods to, say, develop a model of the economy.

50:44David Booth:I mean, a few things are more complicated than that, right? And what I realized is, okay, the theme that we've talked about investing, but in personal life as well, all you can do is make the best decisions you can. You know, that's really it. You can't predict the unpredictable. But if you do, if you're as thoughtful as you can be, then whatever happens, you're likely to accept the outcomes much more readily. And the outcomes aren't always going to be good. That's why they call it uncertainty. And so just be prepared in life. Whether you're talking about trying to manage a two-year-old child.

51:30David Booth:I mean, I had kids. I mean, anybody thinks you can control a two-year-old kid, you know, they know more about parenting than I know, I guess would be a way I would say it. So you just deal with life the way it unfolds. Eventually that two-year-old becomes a three-year-old, and next thing you know, they're through college and married and having kids of their own. So, you know, play for the long haul. You talked about this concept of true wealth, and I know you mentioned it in your book as well. Can you give us a sense of what that means and how folks should go about achieving it? Well, I mean, the story there, I had my second year in the PhD program.

52:11David Booth:I always really wound up tighter than a drum doing research. I went to Christmas and visited my paternal grandparents down in a small town in Kansas. And, you know, it was, you know, my grandparents, they didn't have indoor plumbing. So, you know, they had an outhouse and no central heating, you know. But all my aunts and uncles and cousins, they're all there for the Christmas dinner. And I looked around the room and they were all having a great time. They were really happy, laughing and chuckling. I go, I'm totally stressed out, you know, because I'm thinking about what I'm going to have to be doing when I get back to school.

52:48David Booth:And I go, what's wrong with this picture? They haven't figured out. I mean, they're happy. I'm not. So that's kind of started me down the path that I don't think I was cut out to be a professor. I mean, one of my closest friends over the years has been Gene Fama and his colleague Ken French. They love that stuff. They still do it six days a week, the research. For me, it was work. For them, it's a thrill. So I go, what I need to do is figure out what I can do that will make me happy. So I can be as happy as they are and is not doing research. And that's when I came up with the idea that I want to apply these great ideas are coming down.

53:29David Booth:That's what really improves people's lives. If you can apply it sitting around, theoretically, it's great to debate research findings. But what I really get a kick out of is, and this happens to me a lot, is really the reward of the business. People come up and just say thanks. you know uh before dimensional came along you know i was out there trying to pick stocks or doing whatever i don't even know what i was doing but uh you know you've come up with a sensible way for me to invest and i'm i'm retired now and i'm living a lot better than i ever thought i would be so thank you that's the difference that's that's true wealth and as you think about the next several decades what gives you the most optimism about the future of investing and the ability of individuals to build wealth successfully?

54:16Everything, you know, is getting to be cheaper

54:19David Booth:and cheaper to do. I mean, with AI, it'll be much easier to be an entrepreneur, for example. And I think this entrepreneurial function, human ingenuity, you can call it whatever you want, I think is what really makes our system go. So I'm optimistic about that. You know, with the caveat. I mean, we all understand that AI can be used for good or bad, just like most technologies. Hopefully it'll be used for good. I mean, I don't think, here again, we have much control over it, but it's hard for me to believe given our history of mankind that somehow all these great inventions that are coming up and innovations, whether we're talking about medicine or computing or whatever, you know, I think there's a strong likelihood that it's going to make life better for all of us.

55:13Well, David, this has been a fun conversation for me. I appreciate you sharing all your perspectives and insights with me and our audience. Thank you so much for joining us.

55:22David Booth:Okay. Thanks for having me.

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